# OTC crypto options and forwards explained
An OTC crypto forward fixes today the price of a later trade; an option gives the right to it for a premium. Pricing, collateral, documents and payoffs.
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An OTC crypto forward is a private contract between two parties to buy or sell a set quantity of a digital asset on a future date at a price fixed today, and an OTC crypto option is a private contract that gives its buyer the right, without the obligation, to do so, in exchange for a premium paid up front. Both are negotiated bilaterally, usually between a client and a dealing desk, instead of being bought on an exchange, which means that every term can be tailored and that each party carries the credit risk of the other until the contract ends.
This article is general information for professional readers, not legal, tax or investment advice. Every price, rate, premium and collateral term in the worked example is an illustration built to show the arithmetic, and none is a statement of what desks quote in the market. Whether and how these contracts are regulated depends on the country and on the status of each party.
$20,200,000is what the holder in the worked example receives with a forward, whatever the price on the day
$16,700,000is the least the same holder receives with a put option, after the premium, with the upside left open
3.1xis how much the same put costs at 80% implied volatility compared with 40%
Worked example used throughout: 500 units of a digital asset at a spot price of $40,000, hedged for 90 days. Illustrative figures.
## What is an OTC crypto forward?
An OTC crypto forward is a binding agreement to exchange a stated quantity of a digital asset for a stated price on a stated future date. Both parties are obliged to perform: the seller must sell and the buyer must buy at the agreed price, wherever the market stands on that date.
Four terms define the contract. The underlying is the asset and the quantity, called the notional when expressed in units or in money. The forward price is the price per unit agreed today. The maturity, also called the settlement or expiry date, is the day the exchange takes place. The settlement method says whether the asset itself changes hands or only a cash difference.
No money is paid for the forward itself at the start. The cost is in what is given up: a seller who has locked a price does not benefit if the market rises, and a buyer who has locked a price does not benefit if the market falls.
A forward resembles an exchange-traded future, which is the standardised and centrally cleared version of the same idea. A forward has whatever size, date and reference price the two parties write down, and no clearing house stands between them: the credit protection is whatever they have agreed.
## What is an OTC crypto option?
An OTC crypto option is a contract in which the buyer pays a premium for the right to buy or to sell a stated quantity of a digital asset at a stated price, on or before a stated date. The buyer may walk away; the seller of the option, also called the writer, may not.
A call option is the right to buy. A put option is the right to sell. The price at which the right is exercised is the strike. The last day on which the right can be used is the expiry. A European-style option can be exercised only at expiry, and an American-style option at any time up to expiry; the style is a term to check on the confirmation, not an assumption to make.
An option is described by where its strike sits against the current market. A put with a strike below the market, or a call with a strike above it, is out of the money: exercising it today would be pointless. In the money means the option would already pay something if exercised now.
The two sides of an option carry very different risk. The buyer can lose the premium and nothing more. The seller keeps the premium and takes on the obligation, which is why a desk asks an option seller for collateral and does not ask an option buyer for any once the premium is paid.
| Criterion | Forward | Option, for its buyer |
| --- | --- | --- |
| Obligation | Both parties must perform | Right to perform, no obligation |
| Paid at the start | Nothing | The premium |
| Result if the market moves in your favour | Given up | Kept, less the premium |
| Worst case | Loss grows with the market move | The premium |
| Collateral usually required | From both sides, or from the client | None after the premium is paid |
## What is the difference between a deliverable and a cash-settled contract?
A deliverable contract ends with the asset itself changing hands against payment, while a cash-settled contract ends with a single payment equal to the difference between the agreed price and a reference price observed on the expiry date. A cash-settled forward is usually called a non-deliverable forward, or NDF.
| Point | Deliverable | Cash-settled |
| --- | --- | --- |
| What moves at expiry | The asset one way, the full price the other | One net payment in the settlement currency |
| What must be defined | Network, wallet addresses, delivery deadline | Reference price, its source, the fixing time |
| Main operational exposure | Delivering or paying the full amount first | A reference price that is missing or disputed |
| Suits | A party that wants to sell or receive the asset | A party that wants the price result only |
A cash-settled contract is only as good as its fixing clause. The confirmation should name the price source or the basket of sources, the exact time and time zone of the observation, the way the price is calculated, such as a single print or an average over a window, and the fallback if the source does not publish or the market is disrupted on that day. A deliverable contract exposes each side to the full notional on the settlement day instead of the net difference, and needs its own protections: what happens if the network is congested or halted, and who is entitled to any new asset created by a fork or a distribution during the life of the contract.
## How is an OTC crypto forward priced?
An OTC crypto forward is priced from the spot price plus the cost of carrying the asset to the maturity date, less any income the asset earns in the meantime. The forward price is not a forecast of where the market will be; it is the price at which a desk can hedge the commitment today, by buying or selling the asset now and carrying the position, without expecting a gain or a loss.
In outline, the forward price equals the spot price multiplied by one plus the net carry rate for the period. Take the worked example: 500 units of a digital asset at a spot price of $40,000, so a spot value of $20,000,000, a financing rate of 5% a year, no income on the asset and a 90-day term counted as 90/360 of a year. The carry is 5% multiplied by 0.25, or 1.25%, which is $500 a unit, and the fair forward price is $40,500.
In practice the forward level for a digital asset is read from the market, mainly from listed futures for nearby dates, and it can sit above or below the simple carry calculation because the demand for leverage and the cost of borrowing the asset both move. A forward price below spot is possible when the asset is expensive to borrow or earns a yield.
The desk then quotes around the fair level. In the example the desk bids $40,400 for a client who sells forward, $100 a unit under the fair price. That $100 is the desk's spread: $50,000 on 500 units, or about 24.7 basis points of the fair forward price. The client has locked proceeds of $20,200,000.
## How is an OTC crypto option priced?
An OTC crypto option is priced with a model that takes six inputs: the current price of the asset, the strike, the time to expiry, the interest rate, any income on the asset and the expected volatility of the price. The first five are observable; volatility is the one the two parties are really negotiating.
The premium has two parts. Intrinsic value is what the option would pay if exercised now: a put with a strike of $36,000 on an asset at $40,000 has none. Time value is everything else, the price of the chance that the option ends in the money. It grows with the time remaining and with volatility, and it decays to zero as expiry approaches.
Desks express option prices through implied volatility, the annualised volatility figure that makes the pricing model return the quoted premium. Asking for the implied volatility behind a quote, and comparing it across desks, is the option equivalent of asking for the spread on a spot trade. The chart below shows why it matters: it prices the same 90-day put, struck at $36,000 with the asset at $40,000, at three volatility levels using the standard Black-Scholes formula and the 5% rate of the example.
The same put option at three implied volatilitiesPremium per unit, 90-day European put, strike $36,000, spot $40,000, rate 5%
Model values computed for the worked example, before any desk spread. On 500 units the three premiums come to $645,500, $1,310,500 and $2,009,500.
Nothing about the asset's price changed between those three bars. Protection bought after a sharp move, when implied volatility has already risen, costs a multiple of the same protection bought in a quiet market.
## What does each hedge pay? A worked example
On the same 500 units, a forward fixes the proceeds at one number, a put sets a floor and leaves the upside, and a collar sets both a floor and a ceiling at little or no premium. The table compares the three with no hedge at all, at three prices on the expiry date.
The holder is a treasury that will sell 500 units in 90 days. Spot is $40,000. It has three quotes from a desk, all for 90 days. The first is a forward sale at $40,400. The second is a put with a strike of $36,000 at a premium of $2,600 a unit, which is $1,300,000 in total, or 6.5% of the spot value. The third is a collar: the treasury buys that put and sells a call with a strike of $46,000 for a premium of $2,800 a unit, which leaves it a net credit of $200 a unit, or $100,000.
| Price at expiry | $30,000 | $40,400 | $50,000 |
| --- | --- | --- | --- |
| No hedge | $15,000,000 | $20,200,000 | $25,000,000 |
| Forward sale at $40,400 | $20,200,000 | $20,200,000 | $20,200,000 |
| Put, strike $36,000 | $16,700,000 | $18,900,000 | $23,700,000 |
| Collar, $36,000 to $46,000 | $18,100,000 | $20,300,000 | $23,100,000 |
Each cell can be rebuilt by hand. With the forward cash-settled and the price at $30,000, the treasury sells its units in the market for $15,000,000 and receives $10,400 a unit from the desk, which is $5,200,000, for a total of $20,200,000. At $50,000 it sells for $25,000,000 and pays the desk $9,600 a unit, which is $4,800,000, and ends at the same $20,200,000. With the put, the treasury sells at the higher of the market price and $36,000 and deducts the $2,600 premium: its floor is $33,400 a unit, or $16,700,000. With the collar, the sale price is held between $36,000 and $46,000 and the $200 credit is added.
Two readings follow from the table. The put only beats the forward if the price at expiry is above $43,000, the forward price plus the premium, so buying it is a decision that the upside is worth $1,300,000 to keep. And the collar's attractive premium is paid for with an obligation: at $50,000 the treasury owes the desk $4,000 a unit on the call it sold, $2,000,000 in all, which the higher sale price of its units covers only because it still holds them.
## How do collateral and margin work on a bilateral trade?
Collateral on a bilateral derivative is the cash or assets one party posts to the other so that, if it defaults, the loss on the contract is already covered. It comes in two layers: an amount posted at the start, and further amounts called as the market moves.
The first layer is called initial margin or, in bilateral documents, an independent amount. It is a buffer against the move that could occur between a default and the moment the surviving party replaces the contract. The second layer is variation margin: the contract is revalued, typically every day, and the party whose position has lost value posts the change. A threshold is an amount of exposure left uncollateralised by agreement, and a minimum transfer amount avoids calls for trivial sums.
Take the forward sale in the example with these illustrative terms: an independent amount of 10% of the contract value, a zero threshold and a minimum transfer amount of $100,000. The treasury posts $2,020,000 at the start, 10% of $20,200,000. A month later the market has risen and the forward price for the same date stands at $44,400. The treasury's contract now shows a loss of $4,000 a unit, $2,000,000 in all, and the desk calls that amount as variation margin.
The treasury has not lost money overall, since its 500 units have gained as much. But the gain is in the asset and the call is payable now. If the agreement accepts only dollars or a stablecoin, the treasury must find $2,000,000 in cash. If it accepts the asset itself, a haircut applies: at a spot price of $44,000 and a 30% haircut, each unit counts for $30,800 and the call takes 65 units. A hedge that is sound on paper can therefore fail on liquidity, so model the margin calls a position can generate in a stressed market before signing, and check in the collateral annex what may be posted, where it is held and whether the receiver may reuse it.
Among regulated financial institutions, margin on derivatives that are not centrally cleared follows an international standard. The framework published by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions states that financial firms and systemically important non-financial entities must exchange initial and variation margin on such contracts, that initial margin is exchanged on a gross basis, and that it must be held so that it is immediately available to the collecting party if the other defaults while protecting the posting party as far as the law allows. National rules decide who is in scope; outside it, the collateral terms are what the two parties negotiate.
## What counterparty risk does an OTC derivative carry?
An OTC derivative exposes each party to the risk that the other fails while owing money on the contract, and the size of that exposure changes every day with the market. A 90-day forward or option carries that exposure for 90 days.
The amount at risk is the replacement cost: what it would cost to put the same contract back in place with another counterparty. Suppose the desk in the example fails when the forward price for the expiry date is $30,300. The treasury's forward sale at $40,400 is worth $10,100 a unit, $5,050,000 in all, and that is the claim it holds against a failed firm, less any variation margin the desk had posted. A treasury that posted an independent amount has a second exposure: the return of its own collateral.
Three tools reduce this risk, and they work together. Daily variation margin in both directions keeps the unsecured exposure close to one day's move. Close-out netting, a clause that lets the surviving party terminate all contracts under the agreement and reduce them to one net amount, stops an insolvency official from enforcing the contracts that favour the failed firm while disputing the others. Holding the independent amount with a third-party custodian or in a segregated account keeps it out of the failed firm's general assets. Whether netting and collateral arrangements hold up in an insolvency depends on the law of the countries involved.
## How is an OTC crypto derivative documented?
An OTC crypto derivative is documented in layers: a master agreement signed once between the two parties, a collateral annex, and a short confirmation for each trade. The master agreement carries the standing terms, and the confirmation carries the economics of one transaction.
In the wider derivatives market, the common framework is the Master Agreement published by the International Swaps and Derivatives Association, known as ISDA, with a negotiated schedule and a credit support annex for collateral. In 2023 ISDA published its Digital Asset Derivatives Definitions, which, according to ISDA's announcement, initially cover non-deliverable forwards and options on Bitcoin and Ether, sit under the ISDA Master Agreement and are designed to be extended over time to further products and assets. ISDA published alongside them a paper on the enforceability of close-out netting and collateral arrangements for derivatives that reference digital assets. Desks that do not use the ISDA framework trade under their own master agreement.
From first quote to expiry on a bilateral forward or optionThe order in which the documents and payments occur
Onboarding and master agreementEach party completes its checks on the other, and the master agreement and collateral annex are negotiated and signed.
QuoteThe client states the asset, direction, quantity, expiry, settlement method and, for an option, the strike and style. The desk returns a forward price or a premium.
Trade and confirmationThe trade is agreed by voice or chat and followed by a written confirmation. Both parties check every term against their own record and sign.
Premium and initial collateralAn option buyer pays the premium on the date stated. A forward party or an option seller posts the independent amount.
Daily valuation and margin callsThe calculation agent values the contract, and variation margin moves according to the annex until expiry.
Fixing or exerciseOn the expiry date the reference price is observed, or the option buyer exercises. The settlement amount is calculated and notified.
Settlement and return of collateralThe asset or the cash difference is paid, and collateral is returned net of anything owed.
A confirmation is short, and each of its fields can move money. Check the underlying and quantity, the forward price or the strike, the option type and style, the premium with its payment date and currency, the expiry date with its time and time zone, the settlement method, the reference price and its fallbacks, and the calculation agent and the way its determinations can be disputed.
## Who uses OTC crypto options and forwards, and why?
OTC crypto options and forwards are used by parties that hold, will receive or will need a digital asset and want to control the price at which that happens. The instrument follows from the exposure.
A treasury with known costs in dollars due in three months has the cleanest case for a forward sale: it needs certainty more than upside, and the forward delivers certainty with no premium. A producer such as a mining operator, with output arriving every week, sells forward a share of several future periods instead of one date. A buyer committed to a later purchase in a digital asset faces the opposite risk and takes the opposite side, with a forward purchase or a call.
A holder who does not want to sell uses options because a forward would mean giving up the position's upside entirely. The put is the plain form of insurance. The collar reduces or removes the premium by giving up the gains above the call strike.
The reason to go over the counter instead of to a listed market is fit. A listed contract has fixed sizes, expiries and reference prices. A bilateral contract can match an exact quantity, an exact date such as a vesting or payment date, a chosen reference price and a chosen form of collateral. The price of that fit is the credit exposure, the documentation and a spread that is harder to compare.
## How are crypto derivatives regulated compared with spot?
Crypto derivatives are generally regulated under derivatives or financial-instrument law, which is a different and usually stricter regime than the one that applies to buying and selling the asset itself. A desk that may lawfully trade spot with you is not automatically permitted to sell you an option or a forward.
Two official texts show the pattern. In the United States, the Commodity Futures Trading Commission states in its published primer on virtual currencies that virtual currencies such as Bitcoin have been determined to be commodities under the Commodity Exchange Act, and that its jurisdiction is implicated when a virtual currency is used in a derivatives contract, or where there is fraud or manipulation involving a virtual currency traded in interstate commerce. In the European Union, the Markets in Crypto-Assets Regulation states in its recitals that it expressly excludes crypto-assets that qualify as financial instruments under the Markets in Financial Instruments Directive, which remain regulated under the existing framework for financial services.
The practical consequences recur from one country to the next: the contract may be open only to a defined category of client, the firm offering it may need a specific authorisation, and the trade may have to be reported or margined in a prescribed way. Before the first trade, ask the desk which entity will be your counterparty, under what authorisation it deals in derivatives with a client of your type and country, and which law governs the agreement. Ask your own counsel whether your entity is permitted to enter the contract, how it is classified, and how gains, losses and premiums are treated for accounting and tax, since the treatment of a derivative often differs from that of the asset it references.